With the global economy sputtering and markets in a state of panic, I thought I'd re-read David Smith's The Age of Instability. Smith is economics editor of the Sunday Times of London. His book was published in 2010* and traces the origins of the financial crisis that began in 2007. By Smith's cut-off date (late 2009) it appeared that the crisis had been contained, but nobody yet realized how hard it would be to get things back to anything like normal.
Five years on, I wanted to see how well Smith's analysis stood up, and whether the lessons taught at such great cost had in fact been learned. I'm not very reassured.
Smith notes that the economic meltdown that began in mid-2007 was unlike any in recent memory. For many decades now, recessions have occurred mainly in response to monetary tightening, as central banks have sought to head off inflationary pressures. This was emphatically not the case in 2007: monetary policy was loose because central banks did not see any inflationary risks on the horizon. As Smith argues, this was because they were looking in the wrong places. Consumer price inflation was low because of the flood of cheap products from China and elsewhere, but the flood of liquidity provided by the monetary authorities was in fact creating a series of bubbles in markets for assets, both financial and real estate.
Sound familiar? It should. Almost a decade on, monetary policy is even easier than it was back in 2007, yet there is still no sign of inflation at the consumer level -- indeed, deflation seems to be a more immediate risk. Despite several years of sluggish economic growth, however, equity markets have soared to new highs this year, and real estate markets in cities from London to New York to Toronto have piled on the gains, all of this in response to the cascade of free money.
What differentiates the situation today from that of 2007, and not in a good way, is that the central banks seem to have few shots left in the locker if things get out of hand. None of the major central banks has removed any of the stimulus that they shovelled into markets after the crisis -- indeed, the Bank of Canada has continued to add to it, in the vain belief that cheap money can cure structural weaknesses. Central banks will argue that the persistence of low inflation mandates that they keep things loose, even though we saw how that panned out back in 2007. It's equally likely that none of the central banks has tightened because they simply don't know how they can safely get themselves out of the corner they've painted themselves into.
David Smith has harsh words for some of the key central bankers who set the stage for the crisis of 2007 and then struggled to deal with it. Alan Greenspan at the Fed stands accused of believing his own press clippings as regards the low level of inflation -- it wasn't the Fed's brilliance, but the flood of cheap imports that kept consumer prices in check -- and of acting as a cheerleader for the plethora of complex derivatives that made the crisis so much more severe. Mervyn King at the Bank of England comes in for even harsher treatment: his focus on avoiding "moral hazard" when Northern Rock was teetering on the brink of failure evidently made the crisis much worse that in needed to be.
Neither Greenspan nor King is still around -- indeed, the leadership at all of the main central banks has changed. Janet Yellen, who had a ringside seat as things unravelled under Greenspan and Ben Bernanke, is now in charge at the Fed; until a week or two ago she had seemed set to start raising US interest rates very shortly, but in the wake of the market turmoil in recent days, all bets are off. Mark Carney, ex Bank of Canada, is now at the Bank of England, and had also seemed to be moving towards tightening, but again, recent events have almost certainly changed that outlook. The Bank of Japan, Bank of Canada, ECB and RBA all have relatively fresh leadership in place. Time alone will tell if that's a good thing.
There's one certainty here: if flooding markets with basically free money were the way to secure inflation-free prosperity for all, we'd surely have figured that out long before 2007. It very evidently isn't: rather, it seems likely to be a recipe for recurrent crises, with each one potentially more severe than the last. If anyone can figure a way out of this mess, I'm sure Ms Yellen and Messrs Carney, Poloz et al would be very grateful to hear from you.
* You can buy a previously-owned paperback copy from Amazon for 1 penny!
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